Fiscal cliff may clip Powerball winner

JonnelleMarte

Assuming that somebody has the lucky number for Wednesday’s $500 million Powerball jackpot, the winner might want to use some of their newfound fortune to lobby Congress. The fiscal cliff could put a dent in the prize money, financial advisers say.

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In years past, some investing pros recommended lottery winners spread the payment out over several years to avoid blowing through the prize too quickly. But given the negotiations in Washington to avert the double blow of expiring tax breaks and automatic spending cuts next year, taking the lump sum of roughly $327 million, before taxes, may now be the best move, says Matthew Goff, a financial adviser in Houston. While that figure seems small compared to the total prize, which would be awarded over a period of 30 years for those who took the annuity option, a lump sum “could save you millions in taxes,” says Goff.

(The final size of the winnings will also vary depending on state taxes owed, with the prize being potentially bigger in states like Pennsylvania, Tennessee and Texas, which don’t charge state taxes on lottery winnings, according to USAMega.com. See Powerball Jackpot Analysis)

Though most people dreaming of winning wouldn’t mind sharing the tax woes of the wealthy, hitting the jackpot might change their outlook on fiscal policy, experts say. “If you win the lottery, you’re definitely in the top 1%,” increasing your chances that you could see higher tax rates in the future, says Goff. That could include higher income taxes, bigger levies on dividend income and capital gains, and a new health-care surcharge on high-net-worth earners.

Regardless, the winnings should be enough to last a lifetime— or several— if the lucky winner or winners are careful with how they spend and invest the prize. And because of the sheer size of such a portfolio, the winners could set themselves up to earn an outsize income even if they decide to stay extremely boring with their investments, advisers say. For instance, taken to the utmost extreme, the prize could be stashed entirely as three-month Treasury bills, where the $327 million could earn 0.1% a year, or $327,000.

Here's how to spend the $500M Powerball jackpot

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Marketwatch's Quentin Fottrell has a shopping list for the lucky winner of the Powerball lottery jackpot, which approached $500 million. Photo: Getty Images.

Not that investing pros recommend being quite that conservative. Andrew Feldman, a financial planner in Chicago, says it makes sense to put about 80% of the winnings in bonds where the earnings could create a steady income stream. But instead of sticking all of the money in Treasurys, Feldman recommends using a mixture that also includes investment grade corporate bonds, high yield bonds and municipal bonds. The remaining 20% of the funds can be put in stocks. “You shouldn’t take too much risk,” says Feldman. “You’ve already won.” Those who want to take some risk can put 5% or less of the stock portion in private equity funds, which carry more risk because they are often used to invest in startups or in distressed companies, but can also yield outsized returns if they pay off.

Goff recommends a similar approach, where roughly half of the winnings could be put in high quality corporate bonds—earning roughly $4 million a year. Another 35% of the portfolio could go into tax exempt municipal bonds, which could bring in about $1 million a year of tax free income. And about 14% of the money could go into dividend paying stocks issued by stable large cap companies, which could bring in nearly another $2 million a year—although taxes on that dividend income could rise sharply depending on how lawmakers handle the fiscal cliff. All told, that adds up to an annual income stream of nearly $7 million, that winners can live off of without having to spend any of their actual prize money, says Goff.

Some people may also want to give away some of new-found wealth to distant relatives, or to a good cause. Those who plan to donate a portion to charity should strategize based on how they decide to receive their winnings, says Lisa Featherngill, the managing director of planning and family dynamics at wealth management firm Abbot Downing in Winston-Salem, N.C. With a lump-sum payment, the biggest tax benefit comes from making deductible donations during the same year the money is received, she says. Ideally, a winner could set up a private foundation or donor-advised fund, both of which allow for up-front deductions of funds deposited, but spread out the donations to nonprofits over years to come. If you use such investment vehicles, deductible contributions are capped at 30% of adjusted gross income, versus 50% for direct gifts. But with a lottery win this late in the year, setting up a foundation or fund could prove challenging to do before year-end. “It might be hard to establish something other than a direct gift to the charity,” she says.

Generally, lottery winners who opt for annual lottery payouts have more leeway to give only direct contributions to charity, but the size of the current jackpot could make those lump-sum strategies a smart bet, too. “Even regular payments for that amount of money would push your income up pretty high,” Featherngill says.

Most people buying a ticket today will find the odds aren’t in their favor: the chances of winning the Powerball grand prize on Wednesday are about one in 175 million, according to lottery officials. And even those who win may have to split the prize with coworkers and family members. But that doesn’t stop people from betting on it. Goff, the adviser from Houston, said he was planning to get a $2 ticket before Wednesday’s drawing.

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